What are deferred tax liabilities, and what is the difference between deferred tax liabilities
and deferred tax assets?
Deferred means that something has been postponed, and liabilities means that we owe something.
In this video we explore the underlying concepts of tax deferrals, walk through the journal
entries for deferred taxes, and take a look at the balance sheets of three well-known
companies to see what is driving their deferred tax assets and deferred tax liabilities positions.
Here's the main concept for tax deferrals: the profit that you recognize for "book" or
financial accounting purposes, is not the same as the profit you recognize for "tax" purposes.
One and the same company can have two profit numbers in the same year: the profit per US GAAP
or IFRS that is reported to the stock market, and the profit per individual country
tax rules that is reported to the tax authorities.
When you prepare financial statements for "book" purposes, or review financial statements
prepared on this basis, then remember that "book" profit is the primary perspective,
and "tax reality" needs to get fit in.
You match tax expense in the income statement to "book" profit before tax, and record deferred
tax assets and liabilities on the balance sheet for temporary (timing) differences between
"tax" and "book" accounting.
Let's review what that looks like in journal entries.
If "book" profit equals "tax" profit, then the journal entry for recording the income
tax expense is debit income tax expense in the income statement, and credit income tax
payable on the balance sheet, for the same amount.
When the tax payable is subsequently transferred to the tax authorities,
you debit income tax payable and credit cash.
If "book" profit is lower than "tax" profit, then income tax expense for "book" (financial
accounting) purposes will be lower than income tax expense for tax accounting purposes.
To correctly prepare your US GAAP or IFRS financial statements, you need to introduce
a deferred tax asset for the difference.
In this case, the income tax expense ("book accounting") is 35K, and the income tax for
tax purposes is 40K, hence a deferred tax asset of 5K.
Remember that deferred tax assets and deferred tax liabilities are for temporary (timing)
differences, so when in a future period the income tax expense ("book accounting") is
40K, and the income tax for tax purposes is 35K, this would be offset to the deferred
tax asset account, and the resulting account balance is zero.
If "book" profit is higher than "tax" profit, then income tax expense for "book" (financial
accounting) purposes will be higher than income tax expense for tax accounting purposes.
To correctly prepare your US GAAP or IFRS financial statements, you need to introduce
a deferred tax liability for the difference.
Now that you understand the concept of deferred taxes, and the journal entries for both deferred
tax assets and deferred tax liabilities, let's review some real-life examples of three well-known
companies to make it come alive.
First up: Facebook.
Facebook had net deferred tax assets (which is deferred tax assets minus deferred tax liabilities)
of $1.2 billion at the end of 2017.
The main driver on the side of deferred tax assets is a net operating loss carryforward,
which represents the right to offset future profits against losses from the past.
The main driver of deferred tax liabilities is depreciation and amortization.
The rate at which you depreciate fixed assets for "book" versus "tax" purposes can differ
significantly, and in many cases you depreciate an asset quicker for "tax" purposes than for
"book" purposes.
The quicker you depreciate, the lower the profit,
and the lower the profit, the lower the taxes.
Accelerated depreciation is the depreciation of fixed assets at a fast rate early in their
useful lives.
This type of depreciation reduces the amount of taxable income early in the life of an
asset, so that tax liabilities are deferred.
Later on, when most of the depreciation will have already been recognized, the effect reverses.
The net effect of accelerated depreciation is the deferral of income taxes to later time periods.
Second example: Amazon.
Amazon had a net deferred tax liability of $197 million at the end of 2017, as the deferred
tax liabilities are higher than the deferred tax assets.
Similar to Facebook, Amazon's main item in deferred tax assets is a net operating loss
carryforward, and Amazon's main driver of deferred tax liabilities is depreciation and amortization.
Third example: Exxon Mobil, which is a much more capital-intensive company.
Exxon Mobil's overview actually starts with deferred tax liabilities at the top, and deferred
tax assets below it.
At the end of 2016, Exxon Mobil had almost $30 billion of net deferred tax liabilities.
The deferred tax liabilities are mostly driven by temporary timing differences in the depreciation
of property, plant and equipment.
The main item in deferred tax assets is temporary timing differences in the way pension and
other postretirement benefits are handled for "book" versus "tax" purposes.
That wraps up our deferred tax liabilities versus deferred tax assets discussion: concepts,
journal entries, and corporate examples.
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